Seniors Still Capable of Sound Financial Decisions

Experience, knowledge and expertise can compensate for the
challenges that age-related deterioration present in finance, according to new
research from Columbia Business School.

“Sound Credit Scores and Financial
Decisions Despite Cognitive Aging,” recently published in Proceedings of the
National Academy of Sciences, found evidence that what the researchers call crystallized
intelligence, which is gained through experience and accumulated knowledge, can
be more important to financial success than fluid intelligence, the ability to think logically and
process new information.

The results have important
implications for public policy and for designing effective tools and interventions to help those age 65 and older with complex financial
decisions, the authors say.

According to projections from the
U.S. Census Bureau, the number of Americans age 65 and older will more than
double by the year 2050. The rise of defined contribution (DC) plans puts more
complex decisions in the hands of individuals, and those 65 and older may find
these financial decisions increasingly challenging.

Cognitive decline is real, but does
not spell doom for making financial choices, says Eric Johnson, the Norman Eig Professor
of Business at Columbia Business School and co-author of the study. “An
alternative route to making sound financial decisions comes from experience—and
that improves with age,” Johnson said.

Crystallized intelligence may
function as a kind of intellectual capital that provides an alternate roadway
to sound decisions, the study suggests. To illustrate how this may work, the researchers use the
example of an immigrant in a new country, shopping for the first time,
confronted by new brands sold for prices in an unfamiliar currency.

By contrast, an experienced shopper—who
knows which brands are better, which prices are lower and where favorite brands
are located—has an accumulation of knowledge and expertise that greatly reduces
the need for information processing and active search. In much the same way, the researchers theorized that
older adults, with a greater store of crystallized intelligence, would be able
to create an alternative route to good decisionmaking when their store of
fluid intelligence has dipped.

To test this, they created a
database that combined multiple measures of cognitive ability, economic
preference and personality traits with field observations of economic
performance from credit reports and environmental assessments of realistic
financial decisions.

The More You Know…

The dataset allowed researchers to test
whether the two types of intelligence relate to financial performance and how
age differences in these abilities relate to difference in financial
performance. This allowed them to test a framework that describes age-related
differences in decisionmaking ability by using real-world financial outcomes:
namely, credit scores.

The research found that credit
scores related positively to both fluid intelligence and financial literacy,
and that higher levels of financial knowledge and expertise provide a distinct
and alternate route to sound financial decisionmaking for older adults whose fluid
intelligence is less available. One reason could be older adults’ longer
financial histories and greater experience using financial products.

Using the effect of age alone on
decisionmaking can yield misleading results, Johnson said. “Policymakers and
future researchers should also examine the distinct roles of decreasing
cognitive abilities and increasing—but eventually plateauing—domain-specific
knowledge and expertise when developing tools for the aging population,” he
said.

The researchers believe that
age-specific decision aids and interventions that build on conduits to good
decisions will not only produce better outcomes for older individuals, but
reduce potentially large costs to society.

“With the proliferation of
self-directed benefit plans and the demise of traditional pensions, those who
have accumulated wealth over their lifetime face even greater challenges and
more responsibility when managing their finances than the older population of
previous generations,” said Elke Weber, the Jerome A. Chazen Professor of International Business at Columbia Business School and co-author of the study. “One
way to improve financial decisions across lifespan is to reduce the reliance on
fluid intelligence by limiting decision options, or allowing decisionmakers to
sort options.”

The study is co-authored by Ye Li, of the University
of California at Riverside School of Business Administration; and Jie Gao, A.
Zeynep Enkavi and Lisa Zaval, all at Columbia University. The four-part, Web-based
study assessed the cognitive ability and economic preferences of 478 U.S.
residents between the ages of 18 and 86, using a battery of cognitive,
decisionmaking, and demographic measures.

Researchers leveraged a unique data
set combining measures of cognitive ability and knowledge with credit scores, a
measure of creditworthiness that reflects sustained ability for sound financial
decisionmaking. This dataset allowed researchers to explore whether knowledge
and expertise accumulated from past decisions could offset age-related declines
in cognitive ability.